March 04, 2015 | Nolan Matthias
Variable rates popularity returningBut don't go to your bank for a variable rate
Variable-rate mortgages are once again returning to popularity thanks to low interest rates and the expectation the Bank of Canada will lower the overnight rate again in the near future.
For the last several years, consumers have favoured fixed-rate mortgages primarily due to the expectation rates would rise before they fell. Those expectations however, have not been fulfilled. In fact, the opposite has ensued and rates have gone lower not higher.
Many who recently took out five year fixed mortgages are now realizing they would have fared better with a variable-rate mortgage. In many cases borrowers would have saved thousands, if not tens of thousands of dollars, even though variable rate mortgages often seem riskier, but more often than not have significant financial benefits.
You see, most Canadians choose between variable- and fixed-rate mortgages based on one criterion: whether they believe rates will go up or down. That criterion, however, is flawed and should be used sparingly as a factor to determine what type of mortgage should be chosen.
The more important piece of information that needs to be considered is how much lower the variable rate is at the time of borrowing than the fixed rate. At the moment that difference is 0.6 per cent on the average mortgage. Statistically speaking, if there is more than 0.5 per cent difference in favour of the variable-rate mortgage, the variable will outperform.
Moshe A. Milevsky of the Schulich School of Business at York University performed the most prominent study of Canadian mortgages supporting this theory. In his research paper Mortgage Financing: Floating Your Way to Prosperity Milevsky concluded "a typical Canadian consumer will save between $10,000 and $12,000 on a $100,000 mortgage, if they borrow at prime, compared to the prevailing five-year rate."
Based on Milevsky's findings, it is not surprising the small minority of people who chose a variable-rate mortgage over the last several years have done fairly well. Yet, that doesn't explain why all of a sudden borrowers are returning to variable-rate mortgages over fixed.
What does explain the migration is the consumer's ability to sleep at night. With the Bank of Canada reinforcing rates could stay low for a long period of time, Canadians are once again comfortable they won't lose their shirts if rates rise.
It is important, however, to make smart decisions when obtaining a variable-rate mortgage. Lender selection is crucial. In the event you have to lock in your mortgage at a "big bank", you will end up paying a substantially higher rate than you would at a smaller financial institution.
Variable-rate mortgages should also always be chosen for revenue properties. They have a substantially lower payout penalty and provide the flexibility required when investing in real estate.
To learn more about investment real estate join us March 19 for Mortgage360's next Cash Flow
Club meeting. You can register at www.mortgage360.ca/cash-flow.
Nolan Matthias holds a bachelor of arts in Economics, is the co-founder of Mortgage360 and the author of The Mortgaged Millionaire. Call Nolan at 403-615-6132 with your questions or to set up an appointment with an Accredited Mortgage Professional (AMP).